Yellen to face tough challenges

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If she becomes the next Federal Reserve chair, Janet Yellen w ill face challenges that will require both the steely intellect and the personable style that many attribute to her.

The job as the world's most important banker comes with a daunting to-do list: deciding when to slow the Fed's stimulus, forging consensus from a fractious policy committee and calculating the effects of any economic slowdown from Washington's budget fight. That's in addition to monitoring volatile financial markets and fine-tuning the Fed's communications.

First, though, Yellen will have to get there. She will need to overcome Washington's toxic political environment and win confirmation from the Senate to succeed Ben Bernanke when his term ends Jan. 31.

It's almost enough to make you wonder why she would want the job.

Yellen is widely seen as a “dove” on Fed policy. She stresses the need to use the Fed's tools to boost growth and reduce unemployment in the sluggish aftermath of the Great Recession, rather than worry about igniting future inflation.

That view came through in her brief remarks Wednesday after President Barack Obama announced her nomination. Yellen said more needed be done to strengthen the economy. She added, though, “We have made progress. The economy is stronger, and the financial system is sounder.”

In part for her perceived dovishiness, Yellen has been outspokenly backed by many Democrats in Congress and opposed by some Republicans.

Brian Gardner, Washington political analyst for Keefe, Bruyette & Woods, predicts that Yellen, widely respected as an academic economist and veteran policymaker, will be easily confirmed despite some Republican no votes.

Then the hard stuff begins.

Fed policymakers have been debating when and how to scale back their $85 billion a month in bond purchases designed to spur economic growth by reducing long-term interest rates, driving up stock prices and encouraging borrowing and spending. Yellen was a key architect of this strategy.

Last month, the Fed surprised financial markets by deciding not to scale back its bond purchases. It concluded that the economy wasn't yet healthy enough for the Fed to ease its stimulus even slightly. Fed officials also worried about the budget stalemate that's led to a partial shutdown of the government and threatens to trigger a default on government debt.

Many analysts don't think the Fed will reduce its stimulus before next year. And with the dovish Yellen as chairman, the Fed would likely be cautious about any pullback in early 2014.

For now, there's another problem. There isn't much official economic data to go on. The shutdown that began Oct. 1 forced the Labor Department to cancel its all-important jobs report for September. It's still unclear when the jobs report will come out.

The choice of Yellen to lead the Fed also comes amid worry and uncertainty about how much damage the shutdown might cause the U.S. economy. Graver yet is fear that lawmakers won't raise the government's borrowing limit this month. If they don't, the government could eventually default on its debt, possibly causing another recession and financial crisis.

As chairman of the Fed, an independent agency that steers clear of Congress' affairs, Yellen can be little more than a spectator.

“There's really nothing she could do about the debt ceiling,” noted Joseph Gagnon, senior fellow at the Peterson Institute for International Economics.

One especially delicate challenge for Yellen will be to refine the Fed's communications with the public. Bernanke opened the once-secretive Fed to far more public scrutiny. He was the first chairman, for example, to hold regular news conferences. And the Fed went much further to signal its likely policy actions.

This hasn't always gone smoothly. The Fed has sometimes rattled investors instead of calming them. In fact, according to minutes of the Fed's September meeting, officials worried about delaying a pullback in its bond purchases because they feared it might confuse investors.

A finely calibrated communications strategy will likely be high on Yellen's list of goals.

Further down the list could be another huge challenge: How and when to start shrinking the Fed's portfolio of bonds. Its purchases have swollen its investment portfolio to $3.7 trillion, a record by far. Eventually, the Fed will have to start unloading the bonds without shaking financial markets. It will be a tough task.

Yellen would also take over the Fed at a critical time for China, the world's No. 2 economy after the United States, and other developing nations.

The International Monetary Fund, citing slower growth in China, India and Brazil, downgraded its forecast this week for global economic growth to 2.9 percent this year and 3.6 percent in 2014. Both are 0.2 percentage point weaker than the IMF's previous forecast in July.

Investors have been pulling money out of developing markets, partly to take advantage of rising interest rates in the United States. The Fed might be called upon to help calm worldwide financial volatility.

“The role of the Fed chair is so critical,” said Greg McBride, senior financial analyst at Bankrate.com. “We're not just talking about the U.S. economy. We're talking about the global economy.”

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